A Catering Theory of Earnings Guidance: Empirical Evidence and Stock Market Implications

Abstract

We propose and test a catering theory of earnings guidance. Managers cater to reference point dependent investor preferences by issuing excessively optimistic earnings forecasts if investors' stock returns since purchase are comparably low and vice versa. As predicted by our model, earnings guidance is most biased when managers strongly discount future outcomes, when the stock's payoff uncertainty is high, and when managers face low costs for issuing inaccurate forecasts. Additional analyses based on CEO turnover support intentional managerial catering as underlying mechanism. Catering via earnings guidance shapes stock market prices and induces systematic mispricing which is corrected around the corresponding final earnings announcement.

Keywords: Management Guidance, Catering, Capital Gains Overhang, Stock Mispricing

JEL Classification: G14, G30, M41